Most mutual fund investors were sorely bruised last year, but not those lucky folks who put their money into energy funds, which had average annual 2000 returns of better than 40%.
So can these fund managers keep the pedal to the metal long enough to benefit from the Bush Administration’s new energy manifesto? Rising gas prices at the pump and rolling blackouts are good news for the companies that dominate their portfolios, but hasn’t that already been priced into these stocks?
Well, perhaps not yet. Despite the sharp rise in underlying stock valuations, many of these portfolios still have a reasonably modest price-to-earnings ratio around 20, according to fund tracking firm Morningstar. These funds aren’t screaming buys like they were a year ago, but they may still have room to grow.
Within that average performance, there’s a big difference between funds that overweight big-cap oil companies and those that go after more speculative holdings. Swings in oil and gas prices have a much greater impact on smaller companies like drillers and oil exploration companies. Funds that overweighted these highly speculative companies outperformed last year.
That’s why a fund like Vanguard Energy fund (VGENX), one of the stalwart energy funds with a five-year average annual return of 13.93%, slightly underperformed its peers last year. It’s top holdings: Exxon Mobil (nyse: XOM – news – people), Chevron (nyse: CHV – news – people) and Canadian oil and gas producers Suncor Energy and Alberta Energy.
“The top holdings tend to be large companies with good flexibility. We want to be able to get in and out if we have to,” says Ernst H. von Metzsch, manager of the $1.4 billion fund.
That said, Vanguard Energy still pumped out a 36.4% return in 2000, compared with a 40.37% overall gain for the 18 funds Morningstar tracks that primarily invest in energy stocks, and a roughly 30% return for broader- based natural resource funds. The Standard & Poor’s Composite 500 index suffered a 10.1% loss last year. The no-load Vanguard fund has an annual expense ratio under 0.5%.
A fund like this that invests in big-cap energy tends to have less volatility in both directions. For example, when energy funds as a group dropped 25.3% in 1998, Vanguard Energy was down just 20.5%. By comparison. Fidelity Select Energy Service fund (FSESX) lost 49.7% in 1998, putting it at the bottom of the specialty natural resources category. That fund, which was up 50.3% in 2000, is focused heavily on service companies that drill for oil or build drilling and exploration equipment. Top holdings include Nabors Industries and Weatherford, hardly household names.
Another factor to consider is diversification across this complex industry. For instance, the Vanguard fund holds roughly 50 stocks across most segments of the industry. “We look at the energy sector and split it up into its major components, and try to keep a foothold in each of them,”says von Metzsch. “We then overweight the ones which we think will give off the best returns.”
As with any narrowly focused sector fund, it’s crucial to consider how much exposure you might already have through your other mutual funds. “If an investor has built their portfolio with an eye on broad diversification, then there’s likely some energy exposure in some of the broad core funds,” says Morningstar fund analyst Alan Papier. That’s less true if you choose to go with a fund that invests in smaller holdings.”